Economic Logic, Too

About Me

I discuss recent research in Economics and various events from an economic perspective, as the name of the blog indicates. I plan on adding posts approximately every workday, with some exceptions, for example when I travel.

Friday, December 30, 2011

The US presidential election season in upon us, and of course religion will again be a major factor. While this is rather unique in the Western world that the religion of a candidate would matter, this fact seems very natural to Americans. The basic logic is that a god-fearing politician is less likely to abuse his power, especially in the position of president, where he cannot vie for a better position through exemplary behavior. That seems to be a slam-dunk for religious candidates, yet experience from the rest of the Western world seems to contradict this. In fact in many other countries, overtly religious candidates are suspected of having allegiances primarily with the religion, not the country.

Pavel Ciaian, Jan Pokrivcak and d'Artis Kancs go one step further and try to compare developed economies, that generally rely on secular institutions to enforce laws and rules, to developing economies, that more frequently draw on informal institutions, in particular religious ones. They find that religion-based institutions are weaker because thy hinge on credibility which is difficult to build and easily lost. Secular ones have an explicit and formal legal enforcement mechanism that can also adapt to changing circumstances. The latter means also that religious enforcement systems are best for static societies, while dynamic and growing economies should adopt secular systems. I am not quite sure causality goes this way, but correlations certainly support this.

Thursday, December 29, 2011

Robert Lucas has pushed the idea that business cycles are not that costly that they would need intervention, and the real business cycle literature, at least the early one, has anyway advocated that the government should stay out of this kind of business. It is true that long term growth and understanding why some countries are so poor are more important questions, yet one cannot shake the feeling that recessions are costly. The recent one is more severe than usual and can highlight how its costs can be high, and those costs may persist for some time if the much longer than usual unemployment durations translate into significant losses in human capital and ultimately wages.

Steve Davis and Till von Wachter provide some new evidence of a somewhat different kind. Studying US workers displaced in mass-layoffs, they calculate the present value of a job loss in terms of pre-loss wage years. When the unemployment rate is below 6 percent, the loss is of 1.4 years. Above six percent, as is typical in a recession, the loss is 2.8 years, i.e., much much more than the increase in unemployment duration. One can only imagine that these numbers are going to be much worse for the last recession. And keep in mind that these higher numbers apply to more people in a recession. And it matters in aggregate: if the unemployment rate goes from 5 to 10%, it means 5% of the population loses 1.4 additional years of wages. That is 0.7% of national labor income, or 0.5% of GDP. Not peanuts, and I have not even factored in anything about curvature in utility.

Wednesday, December 28, 2011

Take up rates for various social insurance schemes generally increase from generation to generation, even when their is no change to the rules. That must be either because new generations are more feeble and, say, tend to become more frequently or earlier handicapped, or that they have a higher demand for social insurance benefits, say, because they are feeling more entitled (one can have different interpretations).

Martin Ljunge build a model where younger generations are influenced by what older generations did in the following way: Deciding whether to apply for benefits depends on a "psychic cost" that depends on the take up rate of the previous cohort. The model is the estimated using individual data from the sick leave program in Sweden (I think, this is never explicitly mentioned). It is found that, indeed, having parents taking advantage of social benefits lowers the cost on one doing so oneself. This effect makes up half of the long term increase in the take up rate.

Tuesday, December 27, 2011

Why do people accumulate precautionary savings. Conventional wisdom tells us this happens because people face some shocks to income and they are averse to risk and prudent. Now, we need to be careful here. Risk aversion means that one does not like fluctuations in utility (say, from consumption). Prudence means that one dislikes bad outcomes. Hence they do not mean exactly the same thing, and one could conceive precautionary savings without prudence.

Agustín Roitman shows an example where this works. To do this, he uses a new class of preferences that allows to distinguish clearly risk-aversion and prudence: act - bct3 (it may not be easily visible, this is linear consumption less cubed consumption with some coefficients). It has a relative coefficient of prudence of -1 (ratio of third to second derivative), which is constant and independent of risk aversion. The negative value also means this economic agent is imprudent. As Roitman shows, this agent will still accumulate precautionary savings, hence prudence is not necessary. And except for these assumptions on the utility function, the results holds quite generally.

Friday, December 23, 2011

Rwanda has always struck me as the perfect example of a Malthusian economy. A dense population where land is systematically divided up among descendants, leading to tiny lots that are barely sufficient for survival.Lots are so small that new capital for its exploitation is not relevant, and no technological improvements have any significant bite. In the end the land can only support a population at the edge of famine.

Marijke Verpoorten brings an intriguing connection between the Malthusian theory as applied to Rwanda and the genocide of 1994. Using regional data, she finds that the areas where there was the most urgent population pressure (through density or growth) were also the ones with the most killings. In a way, society was taking care of a business nature and famine could have.

Thursday, December 22, 2011

Europe has suffered a brain drain of top academic scientists that it has tried to reverse by offering better work conditions. The main competitor in the United States, where top scientists are able to attract easy funding and universities are accommodating. While pertains to relatively few people, they are considered to be key, as their reputation can attract better colleagues and graduate students, ultimately improving the rankings administrators vie for. Given the large amounts of money spent by the European Commission and its country counterparts, it is important to understand what motivates scientists to move.

Edward Bergman does this using a survey of 1800 European academics considered to be among in the top institutions. Those who exhibit higher levels of loyalty or "voice" (opinionated on local affairs) tend to stay and try to improve things internally , if necessary. The others prefer to leave when local conditions worsen, and then they have no particular loyalty to stay in Europe when they are just looking for better working conditions. All this is not too surprising. What I find more interesting is that scientists top priority is research opportunities followed by salary, and language preferences is very minor. European universities cannot count on scientists coming home any more.

Wednesday, December 21, 2011

The Economist's BigMac Index is widely used as an indicator of purchasing power parity. I have never been convinced that it is an appropriate indicator, though. But studies keep using it, and teachers keep mentioning it.

The latest is Anthony Landry who uses it to study the border effect, i.e., how a border adds to the cost of transportation. That assumes that BicMacs are all produced in one location and then shipped to all stores worldwide. This clearly is not the case, both for the raw material and for the assembly. While the raw material is produced centrally in each country, it is only rarely passing a border due to regulation and preferences for local product. I thus do not see the point of estimating borders effects with BigMacs.

Tuesday, December 20, 2011

One important feature of the recent crisis has been a significant drop in international trade. There is nothing surprising in this, as it is a regular feature of recessions that imports decrease more than GDP, as they are mostly composed of intermediate and investment goods. And it is well known that investment is very volatile through the business cycle. This are all well-known facts, that are easy to replicate with standard international business cycle models.

Dimitra Petropoulou and Kwok Tong Soo look at this trade drop from the perspective of trade theorists. They use a small open economy model (hence prices are exogenous) with two-period overlapping generations (hence we are talking about long-term movements, not business cycles) with tradable durable goods and a non-tradable non-durable good. There is a fix endowment of labor and capital that can freely be allocated between sectors (hence there is no investment, or savings). Agents can freely borrow and lend within a generation, but not between generations or with abroad.

Why do I mention this? Because Petropoulou and Soo try to reinvent the wheel and make it square. There is a large international business cycle literature that has gone through all this with much more realistic assumption and delivered quantitative results. And this not the first time I see that trade theorists could learn a lot by reading a little bit outside their bubble.

Monday, December 19, 2011

There is much talk about the zero bound on nominal interest rates and how this is constraining the policy options of many central banks. How can of course ask oneself why there would be such a restriction on nominal interest rates. Would it be possible to tax (nominal) money holdings? It is certainly conceivable to have negative interest rates on some bank accounts, and it has happened before. Switzerland and Germany imposed negative rates on non-resident account holders in the 1970's, and the Swiss National Bank is currently contemplating doing this again (New York Times). Sweden imposed them recently on mandatory reserve holdings of commercial banks. There is, however, very little theory on this.

Cordelius Ilgmann and Martin Menner try to make sense of the existing literature on the topic. There are essentially two strands, according to them: the first is started with Silvio Gesell in the 19th century and proposes taxing money, the second lies within the very recent money-search literature.

Gesell was the proponent of an anarchist free-market utopia, the free-economy movement. He proposed that bank notes would need to have a weekly stamp affixed to remain valid, amounting to a 5% tax every year. The stated reason is that while other goods depreciate naturally, money does not and may be withheld from circulation. The tax alleviates that, and should in particular be used in times of crisis, because it increases the velocity of money and prevents its hoarding. That argument can be made for today, but it neglects the influence of inflation on all this, and that is crucial.

The recent money-search literature uses taxes on money holding as a proxy for inflation. My understanding that this is really for analytic convenience but in no way a policy proposal. Indeed, what this literature cares about is the real return on money, not the nominal one. But Ilgmann and Menner run with it and believe there is an endorsement of a Gesell tax.

PS: a third way is discussed in the paper, recently proposed by Willem Buiter. It is based on the silly idea that the various function of money are taken over by separate currencies and backed up by equally silly arguments with money in the utility function.

Saturday, December 17, 2011

I am now entering the fifth year of blogging, and this is the 1000th post, which means I have discussed about one thousand papers. Personally, I find this an incredibly high number. In fact there are so many that I once discussed a paper a second time, forgetting I already did take care of it before.

This is also my yearly opportunity to reassess whether what I am doing here makes sense at all. I obviously get no outside reward for the blog, but that is OK. Only the top bloggers get recognition, and I am not one of them. So it is all about personal gratification, and I think I am still happy about doing it. It is sometimes a struggle to find the time to put things on "paper", but as I still enjoy it, I'll continue for another year.

This year of blogging was dominated by the Bruno Frey saga, which I believe has attracted quite a few new regular readers. That is noticeable because readers from Germany, Switzerland and Australia are much more frequent now. The blog seems also to have an unusually strong and loyal readership in Slovenia.

If you wonder what the most popular posts during this year were, here they are:

I am also encouraged to see that discussion of the posts has picked up compared to previous years. Again, Bruno Frey has helped here, but it is also apparent in the regular posts about Economics research. Unfortunately, spam comments have started flocking to this blog, and I apologize that some make it live before I notice them.

Friday, December 16, 2011

According to Wikipedia, the Oxford English Dictionary defines optimism as "hopefulness and confidence about the future or successful outcome of something; a tendency to take a favourable or hopeful view." This is a poor definition, I think, because it mixes two concepts: a) that one has subjective probabilities on good outcomes higher than what objective ones would warrant, 2) that one is less sensitive to uncertainty. Put it that way, it becomes quite obvious that economists have the tools to separate the two and can thus document what I would call true optimism (or pessimism), a tendency for favor good outcomes in expected utility.

David Dillenberger, Andrew Postlewaite, and Kareen Rozen do exactly this by appealing to Savage's subjective expected utility. If we look at choices of an individual across lotteries, then we should be able to back out both the subjective probability distribution and the aversion to risk. This can actually be a big deal, for example when one wants to give advice in a risky environment. The advisor will try to understand the preferences of the subject, but ignoring optimism/pessimism may lead to a very erroneous assessment of risk aversion. This can be crucial in assessing, say, investment strategies, health care options, or career choices.

Thursday, December 15, 2011

There is unfortunately still some discrimination left in labor markets. Literature has shown that in particular race and gender may matter in some cases, as well as beauty. While this is usually demonstrated by looking at the significance of some characteristic dummies that should not matter in hiring or wage decisions, another way to test for discrimination, at least in hiring, is to compare anonymous job applications to open ones. This is costly to do, and it may infringe some ethical issues, hence this is a rare exercise.

Annabelle Krause, Ulf Rinne and Klaus Zimmermann did this for applications of Economics PhDs to a position in a European institution. I am really puzzled what they expected to learn from such a peculiar market. Indeed, part of the recruitment pool was anonymized before being submitted to the recruitment team. This is very difficult to do properly, as CV, papers and reference letter have plenty of mentions of names and gender. And how to hide that when a candidate has published or is previously known to recruiters? And of course, this can only test up to the selection for the live interview, which is very early in the recruitment process.

In addition, it is very unlikely to find discrimination in such a specialized market. One, recruiting in an academic environment is usually closely scrutinized for discrimination. In fact I have been highly annoyed by the burden it takes to prove one has not discriminated. Two, I would even argue there is reverse discrimination, as recruitment committees are often under strong pressure to hire from "under-represented" groups. Three, the institution that agrees for this exercise is not discriminating consciously, or it is very foolish.

The results are not surprising. No discrimination is found, except a little reverse discrimination for women. It is impossible to generalize the results, as the sample is so small and so specific to this recruiting institution. I really do not see the point of this paper.

Wednesday, December 14, 2011

With the Occupy X movement, discussion about the unequal distribution of income has flared up. At the same time, we are still not over the banking crisis. Several people have linked the two, saying that the large banking sector has lead to more income inequality and that the rich have benefited form the crisis at the expense of the poor. We probably do not yet the data to corroborate any of this, but we have data that allow to look at income inequality through other banking crises.

This is what Luca Agnello and Ricardo Sousa set out to do with a panel dataset from OECD and non-OECD countries. They find some regularities: there is a run-up of income inequality before the crisis hits especially in non-OECD countries; it declines fast thereafter, especially in OECD countries; better access to credit reduces income inequality; and the size of government has no impact on income inequality. The estimates of the paper are rather crude, there is just a lag on the Gini coefficient. I am sure one can tease out more interesting dynamics with a structural vector auto-regression. But the results are still interesting as is.

Tuesday, December 13, 2011

Whenever an activity exerts a negative externality on others, you want to tax it. For example, sin taxes are in place or are proposed for smoking, eating junk food or drinking soda. The reasoning is that these activities are bad for health, and thus end up costing society, even when there is no socialized health care. The fact that these unhealthy people tend to live shorter only partly offsets the direct effect of the externality.

Catarina Goulão and Agustín Pérez-Barahona explain that there is another good reason to tax unhealthy food: unhealthy eating habits are transmitted from a generation to the next even when there is no genetic reason for this to happen. This can also within a group of socially interacting people, which gives obesity or smoking the characteristics of an epidemic. To break this vicious circle of learning, the price mechanism has to come to the rescue. So let's impose more or new sin taxes. We could use the revenue, apparently.

Monday, December 12, 2011

Health care expenditures increase faster than inflation, and I have already offered several explanations for that. But there are more, and they work in rather subtle ways. Today's theme is social security.

Kai Zhao builds a large general equilibrium overlapping generation model to quantify the impact of the introduction of social security in the US on health expenditures. And it is substantial, at 43% of the increase since the fifties. How can this happen? One mechanism is that social security transfers income from the young to the old, and the old have a much higher propensity to spend on health. A second one is that with social security, the utility during retirement years is higher, and thus people want to make sure to have more of those years. Interestingly, the depressing impact of social security on capital accumulation is far too small to counteract the first two effects.

Saturday, December 10, 2011

The American Economic Association launched three years ago the four American Economic Journals, juniors to the American Economic Review. For a journal, three years is a short time, but I still want to assess where they stand for now. From the get-go, let me express again my disappointment that the AEA did not make them open access, the finance would certainly have allowed it, and there was no real need to have print copies. In fact, issues were lying around the department like junk mail that no one bothers to throw away. That was a rather bad omen for the new journals. How has each fared since.

American Economic Journal: Macroeconomics had a horrible start. Editors struggled to fill the first issues as submissions were severely lacking. I suspect this had to do with some very poor choices for the editorial team, to a large extend the usual AEA insiders. A change of editor after a year and some serious recruiting efforts changed all that, and AEJ-Macro is now a success story and the flagship of the AEJs, with impressive impact factors for such a young journal.

American Economic Journal: Microeconomics is rather unremarkable. The market for a new micro journal was thin to begin with. Arguably, the AEA wants to recapture the market share lost to commercial publishers, but with Theoretical Economics launched shortly before (in open access), it was difficult to rally economic theoreticians for this new cause. Unless people finally get fed up with the commercial publishers, AEJ-Micro will remain unnoticed.

American Economic Journal: Economic Policy fares better, but only little. I think it suffers from the fact the most economic research has policy implications, so it is difficult which papers should go there rather than elsewhere. And there are plenty of field journals that attract the top papers in their field. If, say, a health economics paper does not make it in the AER, the author will always prefer sending it to the Journal of Health Economics.

American Economic Journal: Applied Economics is the most worrisome. It has essentially been hijacked for the research agenda of the editor, and for the rest it looks like a junior partner not to the AER, but to the Quarterly Journal of Economics, even with the same mafia mentality (and hence the title of this post). I am surprised that the Association has not yet started rectifying the situation, but then again it is run by people close to the editorial team. I am afraid that this journal, despite being so young, is already the epitome of club mentality in publishing.

In summary, an unexpected success, two non-remarkable journals and a basket case. Not a promising start.

Friday, December 9, 2011

Women are grumpy during their period, and they have good reasons to be so. That this can impact some of their decisions should come as no surprise, yet it can be useful to determine how and how much.

Matthew Pearson and Burkhard Schipper do this by running an experiment that tries to tease out risky behavior and find that women bid higher in an auction when in the most fecund phase of their menstrual cycle or when they are on hormonal contraceptives. OK.

But wait, much like in an infomercial on TV, there is a bonus. In a second paper, the same authors find that the ratio of the length of the index and ring fingers of the right hand has no impact on risk taking. While that seems to be a rather odd measure to look at, there is a good reason to do so. But what annoys me that this is the exact same experiment as in the previous paper, they just use a different characteristic of the participants.

This is a bad case of turning a research project into many thin salami slices. The authors did not even bother rewriting much of the paper, with many part being cut-and-pasted from one to the other. Sadly, this second paper is already scheduled to appear in Experimental Economics. What are we to expect next? A paper about hair color? Astrological sign?

Thursday, December 8, 2011

The Economics profession has been targeted on various fronts lately: one is for a lack of a code of ethics, as exposed by the documentary Inside Job, and another has been the lack of forecasting or warning about the current crisis. With respect to the first, the American Economic Association has convened a committee to create a code of ethics, although unfortunately with a rather narrow mandate. Regarding the second, I believe the accusations are overblown, in part because economists have warned about excessive house prices, because bubbles are by definition unobservable, and because the principal accused, modern macroeconomics, has addressed before the crisis many of the aspects it is being accused of missing. This latter point has mainly been put forward by some economists who have a rather antiquated knowledge of the field, as occasionally addressed here.

One of them is David Colander, who has an admirable art of getting into all the right committees at the AEA. This time, it is the Ethics Committee. In his latest paper, he argues that he is not too worried about the funding of economic research and the lack of disclosures. He is rather bothered by the fact that economists do not have the humility to declare how fragile their results may be. They should be more forthcoming about the risk of error, much as engineers do as they care a lot about failure.

I can see where Colander is coming from, but I do not think this is the fault of the economists, but rather of the public consuming economic research. From personal experience, nobody cares about alternative scenarios. Well many editors do, but people in the industry do not. All they want is a precise number to run with. And even if you include standard errors and such, all that is reported is the median. I am guilty of this on this blog as well, it would take too much time and space to report this for every paper, and it distract from the main message. Only when I think the authors have abused the simplification or neglected possible scenarios do I discuss this, and this does not happen too often. And I think it is very symptomatic how Thomas Sargent and Christopher Sims have recently been ridiculed in the press for refusing to provide instant answers to difficult questions. In short, I think the problem has less to do with the economists than with the readership.

Wednesday, December 7, 2011

Which sport should you encourage your child to adopt? My guess would be cross-country running, swimming and rowing, which have all the important characteristic of encouraging perseverance and long-term planning. They also make your child hang out with the "right people" as these athletes feature prominently among the best students. But these are just my impressions, let us see what can be done with more than anecdotal data.

Charlotte Cabane and Andrew Clark look at US schools, although not quite at the level of athletic detail I would have wished. Healthy students are more likely to participate in sports and later be successful in life. But those participating in sports are also more likely to be healthier. The direction of the causation is not clear. But of interest here is whether participation is sports is an important determinant in latter outcomes. Using the National Longitudinal Study of Adolescent Health, which looks at students who were in grades 7-12 in 1994-95, they can track how the students are doing as late as 2008. In the end, participating in team sports once a week as a student increases the hourly wage by 1.5%. Not a lot but still significant, especially as this for adults in their thirties, and gaps tend to widen later on. Individual sports seem only to have an impact for adult outcomes of girls.

Tuesday, December 6, 2011

When there is some externality, the best way to deal it is with a tax (for a negative externality like pollution) or a subsidy (for a positive externality like education). Yet, I am continuously amazed how this policy using the market mechanism has found little reception in the United States. And economists are also very fond of it: it is the most efficient way to reach an objective, and in the case of a negative externality it even allows to reduce other taxes that distort the wrong way, like income taxes.

Joseph Aldy and Robert Stavins writes a survey article about how to best deal with carbon pollution, comparing a cap-and-trade of pollution permits, clean energy standards and taxation of carbon content. And the latter is the easy winner. And as argued multiple times on this blog, alternative energy should not be subsidized.

Monday, December 5, 2011

As mentioned before, tax authorities are now especially eager to catch tax evaders. But how many of those are actually out there? One would suspect that there are relatively few of them in a low tax country like the United States. But again, the tax authority there has been given relatively few means to pursue investigations and audit rates are surprisingly low. And the tax code is so complicated that the line between tax evasion and confusion is rather blurred.

The Internal Revenue Service, the US federal tax authority, has estimates about how much it is missing in revenue, but as far as I know these numbers are kept well hidden, except for a study in the eighties. Academics have tried to replicate this exercise, obviously with poorer data than the IRS, but with less political pressure. The latest attempt is by Edgar Feige and Richard Cebula. They use a technique similar to one used to calculate the size of an informal economy, a technique based on the quantity of currency in circulation and of check deposits, adjusting for currency suspected abroad and financial innovation. Indeed, tax evaders try to hide income from reporting by using cash transactions. This ignores though those who use tax havens, and I welcome informed guesses on how large a factor that may be.

In any case, Feige and Cebula come to the conclusion that about 20% of reportable income is not properly reported, leading to lost revenue in the order of $400-500 billion every year. They even compute a time series that allows them to figure out what makes the non-compliance rate change. It will not surprise that it increases when national income is higher, when tax rates are higher or when nominal interest rates are higher. It is interesting to see that higher unemployment rates lead to higher non-compliance. That may have to do with more people getting informal income while on unemployment insurance. Still, I cannot shake the feeling that all these results are shaky themselves, as this data is essentially made up.

Friday, December 2, 2011

Global climate change is not only supposed to bring higher average temperatures on earth but also more extreme weather. The latter is possibly the more important consequence, as it has an impact on agriculture and more generally can destroy property. One example is the incidence of hurricanes in the United States, with more and stronger hurricanes likely. What would be the economic impact of this?

Robert Mendelsohn, Kerry Emanuel and Shun Chonabayashi study this using historical data from hurricanes and estimating a damage function. Then they use this function to estimate damages from two scenarios, with and without climate change, taking into account that various US states will have higher populations and incomes in the following decades. In the end, some of the increase in damages is due to this growth, but climate change would have twice that impact. Yet, at $40 billion a year, it still proves to be relatively affordable compared to US GDP. But it is concentrated around the Gulf of Mexico, which shall become even less hospitable with higher temperatures anyway. The outlook for Florida is not too good...

Thursday, December 1, 2011

The current financial crisis is at least partially blamed on lax lending practices in the US mortgage industry. More mortgages were provided to less credit-worthy individuals with smaller down-payments than ever before, until this house of cards fell apart. Of course, this is not the whole story, but at least there is some partial truth to it, right? Now I am not so sure.

Indeed, Geetesh Bhardwaj and Rajdeep Sengupta look at a large fraction of the sub-prime mortgages originated from 2000 to 2006. And they find that the credit-worthiness of their holders, as measured by the FICO score, actually increased (and more so than the general population). How could this be possible? One hypothesis is that mortgage issuers have gradually relied more and more on simple metrics they could enter into some software instead on analyzing other details on an application file. And if you end up relying on a single criterion, the selected applicant will look much better according to this criterion. But if this criterion is not well correlated with actual credit-worthiness and relevant information is neglected, your loan pool becomes more risky.